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Net Net: Promoting innovation and managing change

Pensions stick with hedge funds despite CalPERS exodus

The California Public Employees' Retirement System building in Sacramento, Calif.
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A high-profile hedge fund exodus from a huge pension manager does not appear likely to spark a major movement.

Pensions, investment consultants and other money managers at an industry conference this week dismissed the idea that the California Public Employees' Retirement System's decision to cut a $4 billion slate of hedge funds would stall the otherwise steady increase of public retirement plans into so-called alternative assets.

"I haven't heard any rumblings about other pensions pulling out of hedge funds," Arn Andrews, chief investment officer for the city of San Jose Department of Retirement Services, said Monday on the sidelines of the Alpha Hedge West conference in San Francisco. "You either have a strategy or you don'tpeople are sticking to their plans."

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"I seriously doubt that it is the beginning of a broader or enduring pullout," added John Rohal, executive chairman of Man's North American unit.

Rohal told that he had not heard any talk from Man's pension clients about pulling out of hedge funds. London-based Man had $57.7 billion under management as of June 30.

"Each pension fund has to look at the unique dynamics of their portfolios, but the academic work that has been done over the last 60 years and the practical experience of many pensions and endowments has shown the benefits of increasing diversification, lowering correlations of asset classes and thereby improving returns over long cycles," Rohal said.

An important part of CalPERS' Sept. 15 decision was that it is retaining its activist hedge fund managers, including Breeden Capital Management, Caritca Management and others. They are part of the pension's public equity allocation, not the eliminated Absolute Return Strategy program.

Philip Larrieu, who's responsible for activist fund managers at $188 billion California State Teachers' Retirement System, re-emphasized at the conference the value of such hedge funds and gave no indication that CalSTRS was getting out.

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CalPERS says no to hedge funds
CalPERS says no to hedge funds

Activists aside, $300 billion CalPERS cited three main factors in its decision: "complexity, cost and the lack of ability to scale."

Observers focused on the difficulty CalPERS had in finding enough good hedge funds to take its huge sums of money as the most important reason. That, they said, means the decision won't have broader implications as CalPERS is the largest public pension plan in the country.

"The real reason I think CalPERS got out of hedge funds is the scale issue," said Sean Bill, investment program manager for the Santa Clara Valley Transportation Authority and the city of San Jose Police and Fire Retirement Plan.

Read MoreCalPERS hedge exit may be the first of many

The move has, however, prompted more questions.

"We got a lot of emails flooding in, saying, 'Geez, are we going to be still moving forward with these hedge funds as an asset class?'" Bill said.

But San Jose's pension managers buy into their hedge fund allocations, Bill said, and nothing is changing.

Hedge funds' relatively high fees are also being discussed in the wake of the CalPERS decision.

"The part of the conversation that really gained traction with our plans was the fee component of it," said Andrews, the San Jose pension manager, about the response to CalPERS' move. "(It's) something that our stakeholders are very acutely aware of."

Bill said one way for pensions to reduce fees is to hire internal trading teams, something common at large Canadian retirement systems like the Ontario Teachers' Pension Plan and Canada Pension Plan Investment Board. But that would take a legal change to be able to potentially pay public employees several million dollars for strong performance.

"If I was an advisor to (California Gov.) Jerry Brown ... I would say 'Look to Canada—Canada's got the model,'" Bill said.

Getting pension trustees comfortable with hedge funds is all the more important given the CalPERS announcement, according to observers.

"It's big news. You can't go into your quarterly investment meetings and ignore it," said Robert Christian, head of research at K2 Advisors and Franklin Templeton Solutions. "But asking questions doesn't mean there's going to be a mass exodus from hedge funds."

Christian added that the pensions he works with still believe in the asset class.

"Overall our clients still see the value of hedge funds and that they provide uncorrelated, risk-adjusted returns," he said. "Those are more and more valuable given where we are in the market cycle."